CHAPTER 1 Disadvantages:
o Cost of set-up and report filing
What is Finance?
o Double taxation
Finance is concerned with decisions Hybrid Forms of Business
about money (Cash Flows) Limited Liability Partnership (LLP)
Finance decisions deal with how money Limited Liability Company (LLC)
is raised and used S Corporation
Everything else being equal: Business Organized as a Corporation:
Value Maximized
More value is preferred to less
Limited liability reduces risk increasing
The sooner cash is received the market value
more value it has Ease of raising capital allows taking
advantage of growth opportunities
Less risky assets are more
valuable than riskier assets Ownership can be easily transferred
thus investors would be willing to pay
General Areas of Finance more for a corporation
Goals of the Corporation
Financial Markets and Institutions
Primary goal: stockholder wealth
Investments
maximization — translates to
Financial Services
maximizing stock price.
Managerial Finance
Managerial incentives
Alternative Forms of Business Organization
Social responsibility
Proprietorship
Managerial Actions to Maximize
Advantages:
Stockholder Wealth
o Ease of formation
Capital Structure Decisions
o Subject to few government
Capital Budgeting Decisions
regulations
o No corporate income taxes Dividend Policy Decisions
Limitations: Factors Influenced by Managers that Affect
o Unlimited personal liability Stock Price
o Limited life Projected cash flows
o Transferring ownership is difficult Timing of cash flow streams
o Difficult to raise capital Risk of projected cash flows (earnings)
Partnership Use of debt (capital structure)
Like a proprietorship, except two Dividend policy
or more owners Agency Relationships
A partnership has roughly the An agency relationship exists whenever
same advantages and limitations as a principal hires an agent to act on his
a proprietorship or her behalf.
Corporation An agency problem results when the
Advantages: agent makes decisions that are not in
o Unlimited life the best interest of principals
o Easy transfer of ownership Stockholders versus Managers
o Limited liability Managers are naturally inclined to act in
o Ease of raising capital their own best interests.
Mechanisms to motivate managers to Political risk
act in shareholder’s best interest
Managerial compensation
(incentives) CHAPTER 2
Shareholder intervention
The Annual Report
Threat of takeover
Business Ethics Discussion of Operations
Webster: “A standard of conduct and
Usually a letter from the chairman
moral behavior.”
Business Ethics: A company’s attitude Financial Statements
and conduct toward its employees,
The Income Statement
customers, community, and
stockholders The Balance Sheet
Corporate Governance
Statement of Cash Flows
The “set of rules’ that a firm follows
when conducting business Statement of Retained Earnings
As a result of the Sarbanes-Oxley Act of
Financial Statements
2002, firms are revising their corporate
governance policies The Balance Sheet
Good corporate governance generates Represents a picture taken on a
higher returns to stockholders specific date that shows a firm’s
Forms of Business in Other Countries assets and how those assets are
Non-US firms have higher financed (debt or equity)
concentrations of ownership Cash & equivalents versus other
Nature of relationship with assets
financial institutions differs All assets stated in dollars - only
from U.S. cash and equivalents represent
U.S. firms have a more dispersed money that can be spent
ownership Accounting alternatives – e.g., FIFO
Multinational Corporations versus LIFO
Five reasons firms go “international” Breakdown of the common equity
1. To seek new markets account
2. To seek raw materials Common stock at par, paid-in
3. To seek new technology capital & retained earnings
4. To seek production efficiency Book values often do not equal
5. To avoid political and regulatory hurdles market values
Factors Distinguishing Domestic Firms The time dimension
from A snapshot of the firm’s financial
Multinational Firms position during a specified period
Different currency denominations of time
Economic and legal ramifications The Income Statement
Language differences Presents the results of business
operations during a specified period
Cultural differences
of time
Role of governments
Summarizes the revenues generated statement accounts within firms and
and the expenses incurred between firms
Statement of Cash Flows
The Purpose of Ratio Analysis
Designed to show how the firm’s
operations have affected its cash Gives an idea of how well the company
position is doing
Examines investment decisions Standardizes numbers; facilitates
(uses of cash) comparisons
Examines financing decisions Used to highlight weaknesses and
(sources of cash) strengths
Statement of Retained Earnings
Five Major Categories of Ratios
Changes in the common equity
accounts between balance sheet Liquidity: is the firm able to meet its
dates current obligations
What Information Do Investors Use from
Asset management: is the firm
Financial Statements
effectively managing its assets
Net working capital
Debt management: does the firm have
= NWC = Current assets -
the right mix of debt and equity
Current liabilities
Profitability: the combined effects of
Operating cash flow
liquidity, asset and debt management
= NOI (1-Tax rate) + Depreciation
Market values: relates the firm’s stock
and amortization expense
price to its earnings and the book value
= Net operating profit after taxes per share
+ Depreciation and amortization
expense
CHAPTER 3
Free cash flow
The Financial Markets
= FCF = operating cash flow -
Investments Financial markets are a system that
includes individuals and institutions,
= Operating cash flow - ( in fixed
instruments, and procedures that bring
assets + NOWC)
together borrowers and savers no
Economic Value Added matter the location
=EVA = NOI (1 - Tax rate) - The primary role of financial markets is
[(Invested capital) X (After-tax to facilitate the flow of funds from
cost of capital as a percent)] individuals and businesses that have
surplus funds to individuals, businesses,
Financial Statement (Ratio) Analysis
and governments that need funds in
Ratios are accounting numbers excess of their incomes
translated into relative values Flow of Funds
Ratios are designed to show
relationships between financial Three financial phases
Young adults borrow The primary market - additional shares
sold by established, publicly owned
Older working adults save
companies
Retired adults use savings
IPO market - new public offerings by
Funds transferred from savers to privately held firms
borrowers
Stock Markets
Direct transfer
Physical stock exchanges
Investment banking house
NYSE, AMEX, and regional
Financial intermediary exchanges
Market Efficiency Exchange members
Economic Efficiency - Funds are Floor brokers
allocated to their optimal use at the
Specialists
lowest costs
To have a stock listed
Informational Efficiency - Investment
prices are adjusted quickly to reflect Apply to the exchange
current information
Pay a relatively small fee
Weak-form - all information
Meet the exchange’s minimum
contained in past price
requirements
movements is reflected in current
market prices Over-the-Counter Markets and the
Nasdaq
Semistrong-form - current prices
reflect all publicly available Network of brokers and dealers
information
Auction market
Strong-form current prices reflect
Organized Investment Network
all pertinent information, both
public and private Electronic Communications
Networks
Types of Financial Markets
Regulation of Securities Markets
Money versus capital markets
Securities and Exchange Commission
Debt versus equity markets
(SEC)
Primary versus secondary markets
Jurisdiction over most interstate
Derivatives markets offerings of new securities to the
general public
General Stock Market Activities
Regulation of national securities
The secondary market - trading in the
exchanges
outstanding, previously issued shares of
established, publicly owned companies Power to prohibit manipulation of
securities’ prices
Control over stock trades by associated with the purchase and
corporate insiders distribution of a new issuance of
securities
The Investment Banking Process
Lead or Managing Underwriter:
Investment Banker
The member of an underwriting
Helps corporations design syndicate who actually manages
securities attractive to investors the distribution and sale of a new
security offering
Buys these securities from the
corporation Selling Group: A network of
brokerage firms formed for the
Resells the securities to investors
purpose of distributing a new
Raising Capital: Stage I Decisions issuance of securities
Dollars to be raised Shelf Registrations
Type of securities used Securities registered with the
SEC for sale at a later date
Competitive bid versus
negotiated deal Held “on the shelf” until the sale
Selection of an investment Maintenance of the Secondary Market
banker
When a company is going public
Raising Capital: Stage II Decisions for the first time, the investment
banker is obligated to maintain a
Reevaluating the initial decisions
market for the shares after the
Best efforts or underwritten issue has been completed.
issues
The lead underwriter agrees to
Underwritten Arrangement “make a market” in the stock and
- investment bank keep it reasonably liquid.
guarantees the sale by
Types of Financial Intermediaries
purchasing the securities
from the issuer Commercial banks
Best Effort Arrangement - Credit unions
investment bank gives no
Savings and loan associations
guarantee that the
securities will be sold Mutual funds
Issuance (flotation) Costs Whole life insurance companies
Setting the offering price Pension funds
Selling Procedures The Role of Financial Intermediaries
Underwriting Syndicate: A Facilitate the transfer of funds from
syndicate of investment firms those who have funds (savers) to those
formed to spread the risk who need funds (borrowers)
Manufacturing a variety of financial
products that take the form of either
loans or savings instruments
Benefits of Financial Intermediaries
Reduced costs
Risk/diversification
Funds divisibility/pooling
Financial flexibility
Related services
International Financial Markets
U.S. stock markets represent less than
50% of the total value worldwide
U.S. markets still dominate the stock
markets in other countries
U.S. investors can participate in
international markets by using American
Depository Receipts - mutual funds that
hold stocks or foreign securities
certificates issued in dollar
denominations
Financial Organizations in Other Parts of
the World
U.S. financial institutions are more
heavily regulated
U.S. financial institutions face greater
limitations on branching, services and
relationships with non-financial
businesses
